Altho this article relates to a business startup, the advice given is useful for undertaking any multi-step process. Planning not only what to do, but when and how much, is critical.
Whether You’re Raising $50,000, $500,000, or $5 Million for Your Startup, Make Sure You Understand This 1 Thing
If fail to ask for the right amount at the right time, you risk driving the probability of funding to zero.
As we approach 2020, the funding landscape for startups continues to evolve. From my recent experience, there are four early phases to starting a startup, and each is funded differently. Founders who fail to ask for the right amount at the right time risk driving the probability of funding to zero.
In the 21st century, venture capital investments (in the millions of dollars) are almost exclusively reserved for fuel to grow a startup’s initial traction. If your startup doesn’t have product/market fit, it is unlikely you are going to raise millions of dollars from a VC. But that’s a good thing. Too much money too soon often results in bloated startups that die from premature scaling.
When seeking outside investment, you should only ask for enough capital to get you to the next inflection point (think: first prototype, first sale, the first thousand dollars in revenue.) Investors want to map the stage you’re at by looking at the next inflection point ahead. Then they want to give you the smallest amount of money necessary to get you there. Investors know that additional funds would only lead to comfort, overspending and distractions.
Before you go out and ask for someone’s money to fund your startup, be it an angel investor or professional venture capitalist, here’s what you need to understand.
Round 1: Establish the company.
The first $50,000 comes from founders, friends, and family. Until you put up your own resources, don’t expect others to. This early money is for setting up the venture, and for starting to work on customer discovery. At this point, you are searching for problem/solution fit, which means looking for a large and growing customer segment that has an inelastic need your solution can address in some exponentially better way. By the time you deplete these early resources, you must have to have a good grasp on what you’re going to sell, and to whom you’re going to sell it.
Round 2: Find problem/solution fit.
The next $250,000 is the first money you will take from people you may not know. These can be angel investors, technology accelerators, and seed VCs. This money will be used to bring on full-time employees and to create the first minimum viable product–the prototype that’s just pretty enough that customers will pay for it. Early customer adoption and initial revenue are the milestones investors will look for as a sign you are ready for more money.
Round 3: Bridge to product/market fit.
The next $500,000 is all about finding product/market fit and is also funded by angel investors, accelerators and seed VCs. At this point, you should be looking for low-cost channels to acquire customers while simultaneously looking to increase lifetime value that each customer generates. Until you have found this, you are not ready to scale. Recently, the benchmark of three has been established–meaning you should not scale until the lifetime value generated by a new user far exceeds the cost of adding a new customer.
Round 4: Scale up.
Now comes the VC millions. When you have proven that you can acquire customers for a small amount while generating large amounts of revenue going forward, only then should you go talk to venture capitalists–because only then are you ready to scale.
Applying This to Your Startup
At the sunset of the third decade of tech startups, venture capitalists are only looking to put fuel on the fire to scale up; they are not looking to fund Neanderthals’ quest to find fire. VCs require your business model be proved on a small scale first. They already expect you to know how you will acquire more customers and how you will monetize them.
So before asking a VC or any other person for money, ask yourself three questions:
- At what stage or phase is my startup? What was the last milestone we hit?
- What is the next milestone or inflection point that will exponentially increase the value of my venture?
- Which party is investing at this stage? Friends? Family? Angel investors? Seed venture capitalists? Incubators and accelerators? VCs?
Put another way: Don’t ask for funds to scale up and expand until you’ve proven your company profitable at a small scale. Don’t ask outside investors for money before you have tapped your friends, family, and co-founders, built an MVP, and are full-time. Only seek funds that will get you to the next milestone or inflection point.